Rate Base

Rate Base is the investor-supplied plant facilities and other assets used in supplying utility service to the customer. This investment (rate) base is the amount to which the rate of return is applied (i.e., Rate Base x Rate of Return = Net Operating Income). Rate Base consists of Plant in Service, Telephone Plant under Construction, Materials and Supplies, Working Cash, Depreciation Reserve and Amortization, Deferred Taxes and Customer Deposits.

In estimating plant in service, Volcano applied the ten year average of actual data from 1996 through 2005. At the time of the original AL 335 filing, Volcano did not have actual 2006 data.

CD disagrees with Volcano's methodology used in forecasting plant in service for test year 2008. CD believes that a five year average of actual data from 2002 through 2006 is a more reasonable method because technology today, compared to ten years ago, is changing rapidly. Also more importantly, Volcano in its 2002 GRC filing, applied a five year average in estimating its plant in service.

In forecasting plant in service for test year 2008, CD reviewed Volcano's data from 2002 through 2006 including yearly plant additions and plant retirements. Through data requests, CD requested Volcano to provide justification and market analysis for the purchase of a residential condominium in 2005. Volcano responded and explained that there was no formal cost benefit analysis done for the purchase of the condominium. Volcano states the original intent of the purchase was to have an employee live in the Kirkwood area during the winter season because avalanches and other winter related incidents can sometimes hamper access to Volcano's facilities. Volcano further states that the condominium is currently not being used and is only maintained for future employees.

CD determined it would be more beneficial to ratepayers if Volcano, when necessary, rent an apartment to house an employee during the winter season instead of maintaining a condominium for future employees. Therefore, CD recommends the Commission disallow $849,002 ($40,000 from 2002 and $809,002 from 2005) from Volcano's plant in service for the purchase of the condominium before forecasting plant in service for the 2008 test year.

With respect to telephone plant, Volcano states that its central office switching equipment, a DMS-100⁵, located in the Pine Grove central office has been in service since 1981. Volcano further states that the DMS-100 has been continually upgraded to meet the needs of their customers and some of these upgrades have been substantial. In addition, Volcano states manufacturers are not willing to upgrade these "older" switches for new network requirements. Volcano informs CD that an upgrade to a new "softswitch"⁶ is necessary as the worldwide network is evolving from analog to digital circuits, through Signaling System 7⁷ (SS7) to packet switching. Volcano also states that upgrading the switch allows the ability to interface its remote site concentrators with Internet Protocol (IP) interfaces. Volcano invested $1,212,754 to upgrade the DMS-100 to the CS2000 (CS2K) "softswitch" in 2007.

Volcano states that the upgrade to the (CS2K) "softswitch" requires reducing the distance to existing remotes from 12,000 ft. to 4,000 ft. to enhance the ability to provide services associated with the upgrade. By reducing the distance to existing remotes, additional fiber is necessary between remotes and residential/businesses to be able to feed additional circuit equipment. In its original filing, Volcano also states that the upgrade to the CS2K will allow the company to upgrade its remote switches over a reasonable time period. Volcano scheduled the replacement of 21 of 50 remotes over a three-year period staring with seven remotes in 2007, seven remotes in 2008 and six remotes in 2009 at $150,000 per remote. However, in an electronic mail dated May 23, 2007, Volcano proposes to change its remote replacement schedule to five remotes in 2007, nine remotes in 2008 and six remotes in 2009. Volcano states that this is necessary because of its plan to complete its cable television system upgrade. Volcano proposes investing $3,189,580 for test year 2008.

CD does not believe that Volcano's network transport conversion from Time Division Multiplexing (TDM) circuit switching to IP transport packet switching just to keep up with the industry trend is necessary to provide reliable telephone service to its customers. First, CD staff requested Nortel (manufacturer), to clarify the necessity of the "softswitch" upgrade. Nortel informs CD that the DMS-100 is a reliable switch and "the DMS-100 is fully supported by Nortel". Nortel states the CS2K "softswitch" is not essential in provisioning telephone service to its customers. Nortel further states that, "the DMS-100 handles all Time Division Multiplexing (TDM)⁸ traffic, the CS2K handles all VoIP traffic. This platform will allow Volcano to eventually migrate to IP Multimedia Subsystem (IMS) which will allow Volcano to integrate data, voice, video and wireless into one platform".

The industry is in a state of flux relating to adopting standards for this type of new equipment. CD believes that it is not prudent to invest in IP switching and transport until the IP industry is standardized so that there are fewer "new technology" risks. This in turn limits the risks to ratepayers. To confirm this, CD contacted other carriers and CD was informed that these carriers have only installed IP softswitches in a few central offices, mainly where they are experiencing new growth. CD was also informed that these carriers plan on keeping legacy TDM switching and transport for as long as it is useful.

In addition, Volcano indicated that its customer base is primarily interested in basic telephone service and has not expressed interest in advanced services. Consequently, it is unclear as to Volcano's reasons for investing in facilities that provide advanced services or invest in facilities whose functionalities and capacities far exceed the need the Volcano customers asserted. CD believes that until such time where there is demonstrated future demand, it is premature for Volcano to put in IP equipment.

CD requested Volcano to provide a business plan which includes a cost benefit analysis of the present value of the options between: a) maintaining the existing DMS-100 with required maintenance versus b) the purchase of a new CS2K "softswitch" for telephone company-regulated telephone services. Volcano states that there was no business plan for the IP upgrade to the switch as it did not create a "new business" but is simply an upgrade to the existing DMS-100".

Additionally, Commission Resolution T-16697, dated December 17, 2002 approved Volcano's request to accelerate the depreciation of the then existing switch in anticipation of the installation of a new softswitch in 2005. However, Volcano did not install the softswitch in the timeframe anticipated by Resolution T-16697. Instead, Volcano delayed installation of the softswitch until 2007. Given that the new softswitch investment was approved for 2005 and Volcano chose to delay its installation until 2007, CD recommends that Volcano's Total Company (i.e. prior to jurisdictional separations) depreciation expense for 2005 be adjusted by $535,096. This $535,096 adjustment is derived by calculating the present value of the difference between the accelerated depreciation Volcano was authorized to take in 2005 by Resolution T-16697 and the depreciation expense the company should have taken in 2005 for the softswitch not being installed in 2005.

Broadband deployment and accessibility is currently a priority to the State. With this understanding, CD staff confirmed that Volcano makes available DSL service to 99% of its customers through its affiliate, Volcano DSL. Out of this 99%, 70% have access to 6 megabits per second (Mbps) throughput. The average DSL connection in California is about 1.5 Mbps and studies show that anything in excess is only required to handle video.

At current prices, a majority of Volcano customers do not subscribe to basic DSL service. Volcano states that as of May 2007, 3,841 or approximately 34% of its 11,251 customers subscribe to DSL service. Out of these 3,841 customers, 1,755 or approximately 45% DSL customers subscribe to Volcano's basic DSL service with a speed of 384 Kilobits per second.

CD therefore, recommends that the Commission: a) adjust Volcano's Total Company depreciation expense on the non-softswitch investment for 2005 in the amount of $535,096, and b) exclude $1,750,000 from Volcano's 2008 plant investment for the additional fiber between remotes and residential and business customer locations. Additionally, CD believes that based on a comparison with other small telephone company plant additions in California, and Volcano's inability to fulfill its original proposal, Volcano's proposed remote replacement schedule is too aggressive for a small company and recommends the Commission approve CD's proposed remote replacement schedule of five remotes for 2007, five remotes for test year 2008 and five remotes for 2009.

Volcano also proposes to place several new inter-exchange fiber routes between Volcano and Calaveras. Volcano states that redundant routes are necessary as a back-up in cases of storms or fires. CD finds Volcano's proposal reasonable and recommends the Commission accept Volcano's proposed investment of $250,334 for test year 2008 for these redundant routes.

Construction Work In Progress

Volcano proposes that its 2008 "Construction Work in Progress" (CWIP) account equal $2,200,000. CD does not agree with Volcano's proposal but acknowledges that the Commission has historically allowed the inclusion of CWIP in the rate base for general rate cases and for annual CHCF-A filings. Based on previously accepted general rate cases and CHCF-A filings, CD proposes a 2.8% of average plant balance or $2,131,968 as a reasonable estimate for CWIP (Appendix B).

Materials and Supply

Volcano's estimated amount for materials and supply (M&S) is based on a percentage of average plant balance. This is a reasonable method since the inventory of parts and supplies usually increases at the same rate as the company's plant. In its filing, Volcano uses 0.6% of its average plant balance in 2008 for its M&S. CD has reviewed Volcano's previous materials and supplies accounts and believes 0.6% of average plant balance to be reasonable estimate for M&S in rate base for test year 2008. CD estimates Volcano's M&S for test year 2008 at present rates to be $396,431 (Appendix B).

Working Cash

Volcano and CD used the Commission's Standard Practice U-16 Simplified Method to develop its working cash estimate. CD's total company working cash estimate for test year 2008 at present rates is $706,588 or $95,412 less than Volcano's estimate of $802,000. This difference is due to the difference between CD and Volcano's estimated expenses.

⁵ The DMS 100 is an electronic switching system establishing a connection between two telephone lines, or two switching systems.

⁶ Softswitch is an electronic switching system designed to support next generation networks that rely on packet-based voice, data and video communications technologies that can interface with a variety of transport technologies including copper, wireless, and fiber.

⁷ SS7 is the protocol used in the public switched telephone system (the "intelligent network" or "advanced intelligent network") for setting up calls and providing services. SS7 is a separate signaling network that is used in Class 4 and Class 5 voice switches.

⁸ TDM is a technology that transmits multiple signals simultaneously over a single transmission path